Banks and Rising Bad loans and Losses:
This refers to the edit Rising Loan losses Price of Stimulus( Et Dt,24 May 2011). Banks in India particularly public sector banks have to be run as desired by the Government and the Reserve Bank due to socio economic conditions and the need to uplift weaker segment of the economy. Running banks purely on professional lines and as per the cyclical conditions of the economy is simply ruled out as long as agriculture sector and large segment of the population who remain dependent upon the rural economy remain weak. This results in cross subsidisation in different ways and formation of larger non performing loans (NPLs).
Because of high interest rate on certain loans, lower growth of the economy and preferential type of loans not linked to viability, NPLs of banks increase and the Government comes to final rescue in case of any bail out of banks. Larger NPLs mean more provisions, lower profits, lower deposit rates, lower distribution of dividend affecting all stake holders of banks. NPLs are part and parcel of banks and the only solution to contain the impact of this menace is to have a permanent approach to contain the emergence of NPLs and to ensure that banks do not suffer on account of NPLs.Since the borrowers' poor performance inter -alia is the basic cause for NPLs, it is ideal to have a solution involving borrowers. Rate all the borrowers based on their conduct of operations and levy a small sum from them on the basis of their rating to have a Precautionary Margin Reserve Fund to take care of NPLs. Banks and the Government if necessary can support the fund based on certain criteria in the interests of the institutions and their long term viability.This fund over a period would be sufficient to cover the risks arising out of NPLs.
Dr.T.V.Gopalakrishnan
Friday, May 27, 2011
Tuesday, May 24, 2011
Window Dressing of Balance Sheet
Banks Balance sheets and SBI's Correct Position
This referss to the News items SBI Net slumps99 % on bad loans, pensions and Ghost from the past Returns to Haunt SBI appeared in the ET, dated 18th May 2011.It has become a ritual in banks that when ever there is change of guard at the top, the first quarter reasults under the new person show very poor performance and the achievements of the former guard turns out to be false and unimpressive. Such announcements by the new incumbent only indicate that many things have been and can be hidden under the carpet and the Accountants, Auditors and the Regulators also do not provide correct information or vouch for the authenticity of the figures.Particularly, the bad loans shoot up and the profits decline sharply under the new guard. The first quarter results and the balancesheet figures cannot have too much of variance unless the balancesheet figures are falsely prepared.
Investors and other stake holders do not know the correct position and they go by the reports that appear every now and then in the papers and elsewhere. If the present position of SBI is true, then the earlier reports compiled by the Chartered Accountants and vetted by the Auditors and regulators are wrong , then the whole matter needs to be thoroughy probed. For change of sensitive figures frequently, the Accountants, Auditors and the regulators of banks owe an explanation to investors and all stakeholders. Window dressing of balancesheets is neither desirable nor permissible.
T.V. Gopalakrishnan
( edited version of this letter appeared in ET,23 May 2011)
This referss to the News items SBI Net slumps99 % on bad loans, pensions and Ghost from the past Returns to Haunt SBI appeared in the ET, dated 18th May 2011.It has become a ritual in banks that when ever there is change of guard at the top, the first quarter reasults under the new person show very poor performance and the achievements of the former guard turns out to be false and unimpressive. Such announcements by the new incumbent only indicate that many things have been and can be hidden under the carpet and the Accountants, Auditors and the Regulators also do not provide correct information or vouch for the authenticity of the figures.Particularly, the bad loans shoot up and the profits decline sharply under the new guard. The first quarter results and the balancesheet figures cannot have too much of variance unless the balancesheet figures are falsely prepared.
Investors and other stake holders do not know the correct position and they go by the reports that appear every now and then in the papers and elsewhere. If the present position of SBI is true, then the earlier reports compiled by the Chartered Accountants and vetted by the Auditors and regulators are wrong , then the whole matter needs to be thoroughy probed. For change of sensitive figures frequently, the Accountants, Auditors and the regulators of banks owe an explanation to investors and all stakeholders. Window dressing of balancesheets is neither desirable nor permissible.
T.V. Gopalakrishnan
( edited version of this letter appeared in ET,23 May 2011)
Sunday, May 22, 2011
Is it the appropriate time to deregulate savings bank interest rate?
Is it the appropriate time to deregulate savings bank interest rate?
T. V. Gopalakrishnan
May 22, 2011:
The Reserve Bank of India has been toying with the idea of deregulating savings bank (SB) interest rate for quite some time and accordingly, released a discussion paper inviting comments from public.
The SB deposit rate, which continues to be under regulation, has been enhanced from 3.5 per cent to 4 per cent in the Credit Policy announced on May 3.
SB accounts are basically maintained and operated more by the middle-class and lower middle-class people. A majority of the people from rural semi-urban and urban segments perhaps maintain only SB accounts as a matter of convenience and thrift habit.
Salaried class, senior citizens, pensioners and small savers maintain SB accounts and keep heavy balances according to their standards. Even among them, the slightly better off and highly literate maintain only very minimum balances in SB accounts as they prefer to save in other instruments such as recurring deposits, fixed deposits, equity shares, bonds real estate and commodities.
Minimum balances
Many of the banks, particularly the new generation and foreign banks, insist on minimum balances of comparatively high order and high net worth individual's business class people prefer to maintain their accounts with these banks as status symbol and for personalised attention.
Foreign banks have a knack of avoiding ordinary people from opening SB accounts by keeping the minimum balances beyond the reach of even some of the upper middle-class people by Indian standards. Their service charges are also beyond affordability for many.
Public sector banks and old generation private sector banks allow people to open SB accounts with very minimum balance and this is a boon to many particularly to those who belong to lower strata of the society.
With the invasion of ATM cards basically linked to SB accounts, the operations in the SB accounts have become convenient and user friendly. With Internet and mobile banking facility, highly educated well employed and high net worth class of people keep SB accounts and maintain very high balances.
Majority of senior citizens, pensioners and a large segment of people belonging to pre-reforms period, in particular, continue to have banking with old generation private sector banks and public sector banks out of sentimental value and because of mental block to switch over to modern technology related banking.
From banks' point of view
With the demat accounts made compulsory for investments purposes, most of the banks have linked SB accounts with demat accounts. Individuals having investments in capital market which form only an insignificant portion of over all investors, maintain such demat-linked SB accounts keeping relatively very high balances. Deregulation of such SB accounts' interest rate is highly desirable.
There are different categories of banks operating in the system and the SB accounts with them have different backgrounds. There are local area banks, regional rural banks, cooperative banks, old generation private sector banks, new generation private sector banks, foreign banks, nationalised banks and state bank group.
There is no level-playing field among various bank groups as far as deposit mobilisation is concerned. The only uniformity among these bank groups is in the matter of SB interest rate.
Deregulation of the SB rate can adversely affect some of the bank groups which thrive on SB deposits and take care of the so-called financial inclusion which unfortunately have not taken off well despite all efforts both from the RBI and the Government.
How some of the bank groups deliberately skip financial inclusion is well-known and deregulation of SB interest rate will further facilitate them to exclude financial inclusion right royally.
The local area banks are very few in numbers and they survive basically with SB deposits. Financial inclusion which is very essential and talked about loudly can be possible only if such banks are encouraged and supported by the RBI. These banks though operate in rural areas are also high tech banks and perform comparatively well in reaching out to the poor and needy. Regional Rural Banks enjoy a very large share of SB deposits from poor farmers, retailers and small business operators.
The SB bank deposits of these banks are from poor masses and they deserve better rate of interest if possible linked to inflation trend. Willy-nilly deregulation somehow encourages greed and this would affect the morale of the masses and only lead to exploitation of the masses.
Small savers need protection of their interest income. The economy has not matured enough and exploitation has been the undesirable trend. Maximise profit at any cost even at the cost of the poor people has been the trend and this can be cited in a way as one of the reasons for high inflation. This ground reality cannot be ignored while deregulating SB interest rate.
Old generation private sector banks continue to enjoy the loyalty and support of large segment of customers. Their business operations have some unique characteristics because of their regional base and they extend personalised service for their deposit customers. Deregulation of interest rate can result in undercutting among these banks and it may result in the shift of deposits from one bank to another resulting in the Asset-Liability mismatch and also increase in the cost of operations.
They have gold loans and advances against deposits having linkages with SB deposits. Their clientele except perhaps in urban and metropolitan centres prefer to have the transactions personally in the branch premises and do not use the ATM cards even if they hold the cards. For such banks, the disturbance on the deregulation of interest rate of SB account would be rather high and adjustment would take a long time.
High tech banks
New generation private sector banks and foreign banks are high tech banks and the deposit customers are also equally high tech when compared to other banks' customers. Their staff also belongs to the post reforms period and their banking knowledge and practices differ vastly from old private sector banks and even from public sector banks. They have a distinct advantage over other banks in adopting new reforms in terms of cost, technology, manpower and clientele understanding. They will welcome the deregulation of interest rate on SB account as they thrive on competition and maximisation of profit. They have no other consideration other than profit and deregulation of interest will be an opportunity for these banks to further showcase their competitiveness, particularly before some of the public sector banks.
Public sector banks, which enjoy the backing of the Government in guaranteeing the safety of depositors' funds, have maximum deposits in SB accounts. In case, the SB rate of interest rate is deregulated, they will be the worst sufferers. All PSBs cannot compete with private sector banks and many will lose their share of deposits in case rate offered by the private sector banks turns out to be higher than what they offer.
If they have to offer higher rate of interest to maintain their share of SB deposits, it may adversely affect their bottomlines and the Government will have to ultimately bear the cost. The deregulation cost will finally have to be borne by the Government and other stakeholders. This will also derail the financial inclusion programme of the Government and the RBI as PSBs may not be keen to go in for small deposit accounts.
Further, deregulation will have more asset liability mismatch in PSBs than in other banks because of their larger share of SB accounts and presumably bigger share of infrastructure loans extended based on the permanent / core share of SB deposits.
Co-operative banks have a sizeable SB deposits and if interest rate is deregulated it may even sound the death knell for the entire cooperative system which is already under stress.
Options for Deregulation
Though deregulation is desirable and may be necessary to make the monetary policy transmission more effective as claimed by the Reserve Bank, this can wait for some more years till the economy matures and depositors understand the nuances of finance and its implications.
As it is, only a very few percentage of the depositors understand the full implications of deregulation and the possibility and capability of the system taking the depositors for a ride because of greed for profit, general laxity in corporate governance in protecting the interests of the masses and the visible tendency to exploit any situation (even if the deregulation is well intended) through corruption and other malpractices taking advantage of the ignorance of the masses cannot be ignored.
The expectation that deregulation will increase the cost of funds which is already ruling high is also not very conducive for the present.
The ideal time for deregulation would be when the inflation is low, economic growth is good, and the average cost of funds in the economy is at a reasonable level.
No doubt SB interest rate deregulation has its advantages and is welcome in the overall interests of the economy in general and banking system in particular, the timing and approach need to be well calibrated. Partial deregulation in a phased manner can be initially attempted.
Banks which have kept very high level of minimum deposits for SB accounts and have linked the deposit accounts to ATM, Internet and mobile banking and demat accounts can consider deregulating the deposit interest rate and their operations need to be closely monitored by the RBI.
SB accounts maintained by institutions such as charities, trusts, clubs, associations, and NGOsin any bank can also be deregulated. The RBI can also consider keeping a ceiling say Rs 1 lakh for SB accounts. Any amount exceeding Rs 1 lakh should move to either current account or FD account. Interest rate on SB accounts should have a bearing on the inflation and should be periodically revised. SB accounts should be only for individuals.
Surging inflation
The economy is in the grip of high inflation. The cost of deposits and the cost of funds are already very high. In case of deregulation of SB deposit interest rate, the immediate reaction would be to hike the interest rate further beyond the 4 per cent already effected.
Since the NIM is beyond three per cent and banks are reluctant to bring it down, the possibility of banks enhancing service charges to recover the additional interest expenditure cannot be ruled out. Financial inclusion is far from satisfactory. In such a scenario, the timing for deregulation does not seem to be very appropriate.
This article appeared in The Hindu Business Line dt. 23rd May 2011.
T. V. Gopalakrishnan
May 22, 2011:
The Reserve Bank of India has been toying with the idea of deregulating savings bank (SB) interest rate for quite some time and accordingly, released a discussion paper inviting comments from public.
The SB deposit rate, which continues to be under regulation, has been enhanced from 3.5 per cent to 4 per cent in the Credit Policy announced on May 3.
SB accounts are basically maintained and operated more by the middle-class and lower middle-class people. A majority of the people from rural semi-urban and urban segments perhaps maintain only SB accounts as a matter of convenience and thrift habit.
Salaried class, senior citizens, pensioners and small savers maintain SB accounts and keep heavy balances according to their standards. Even among them, the slightly better off and highly literate maintain only very minimum balances in SB accounts as they prefer to save in other instruments such as recurring deposits, fixed deposits, equity shares, bonds real estate and commodities.
Minimum balances
Many of the banks, particularly the new generation and foreign banks, insist on minimum balances of comparatively high order and high net worth individual's business class people prefer to maintain their accounts with these banks as status symbol and for personalised attention.
Foreign banks have a knack of avoiding ordinary people from opening SB accounts by keeping the minimum balances beyond the reach of even some of the upper middle-class people by Indian standards. Their service charges are also beyond affordability for many.
Public sector banks and old generation private sector banks allow people to open SB accounts with very minimum balance and this is a boon to many particularly to those who belong to lower strata of the society.
With the invasion of ATM cards basically linked to SB accounts, the operations in the SB accounts have become convenient and user friendly. With Internet and mobile banking facility, highly educated well employed and high net worth class of people keep SB accounts and maintain very high balances.
Majority of senior citizens, pensioners and a large segment of people belonging to pre-reforms period, in particular, continue to have banking with old generation private sector banks and public sector banks out of sentimental value and because of mental block to switch over to modern technology related banking.
From banks' point of view
With the demat accounts made compulsory for investments purposes, most of the banks have linked SB accounts with demat accounts. Individuals having investments in capital market which form only an insignificant portion of over all investors, maintain such demat-linked SB accounts keeping relatively very high balances. Deregulation of such SB accounts' interest rate is highly desirable.
There are different categories of banks operating in the system and the SB accounts with them have different backgrounds. There are local area banks, regional rural banks, cooperative banks, old generation private sector banks, new generation private sector banks, foreign banks, nationalised banks and state bank group.
There is no level-playing field among various bank groups as far as deposit mobilisation is concerned. The only uniformity among these bank groups is in the matter of SB interest rate.
Deregulation of the SB rate can adversely affect some of the bank groups which thrive on SB deposits and take care of the so-called financial inclusion which unfortunately have not taken off well despite all efforts both from the RBI and the Government.
How some of the bank groups deliberately skip financial inclusion is well-known and deregulation of SB interest rate will further facilitate them to exclude financial inclusion right royally.
The local area banks are very few in numbers and they survive basically with SB deposits. Financial inclusion which is very essential and talked about loudly can be possible only if such banks are encouraged and supported by the RBI. These banks though operate in rural areas are also high tech banks and perform comparatively well in reaching out to the poor and needy. Regional Rural Banks enjoy a very large share of SB deposits from poor farmers, retailers and small business operators.
The SB bank deposits of these banks are from poor masses and they deserve better rate of interest if possible linked to inflation trend. Willy-nilly deregulation somehow encourages greed and this would affect the morale of the masses and only lead to exploitation of the masses.
Small savers need protection of their interest income. The economy has not matured enough and exploitation has been the undesirable trend. Maximise profit at any cost even at the cost of the poor people has been the trend and this can be cited in a way as one of the reasons for high inflation. This ground reality cannot be ignored while deregulating SB interest rate.
Old generation private sector banks continue to enjoy the loyalty and support of large segment of customers. Their business operations have some unique characteristics because of their regional base and they extend personalised service for their deposit customers. Deregulation of interest rate can result in undercutting among these banks and it may result in the shift of deposits from one bank to another resulting in the Asset-Liability mismatch and also increase in the cost of operations.
They have gold loans and advances against deposits having linkages with SB deposits. Their clientele except perhaps in urban and metropolitan centres prefer to have the transactions personally in the branch premises and do not use the ATM cards even if they hold the cards. For such banks, the disturbance on the deregulation of interest rate of SB account would be rather high and adjustment would take a long time.
High tech banks
New generation private sector banks and foreign banks are high tech banks and the deposit customers are also equally high tech when compared to other banks' customers. Their staff also belongs to the post reforms period and their banking knowledge and practices differ vastly from old private sector banks and even from public sector banks. They have a distinct advantage over other banks in adopting new reforms in terms of cost, technology, manpower and clientele understanding. They will welcome the deregulation of interest rate on SB account as they thrive on competition and maximisation of profit. They have no other consideration other than profit and deregulation of interest will be an opportunity for these banks to further showcase their competitiveness, particularly before some of the public sector banks.
Public sector banks, which enjoy the backing of the Government in guaranteeing the safety of depositors' funds, have maximum deposits in SB accounts. In case, the SB rate of interest rate is deregulated, they will be the worst sufferers. All PSBs cannot compete with private sector banks and many will lose their share of deposits in case rate offered by the private sector banks turns out to be higher than what they offer.
If they have to offer higher rate of interest to maintain their share of SB deposits, it may adversely affect their bottomlines and the Government will have to ultimately bear the cost. The deregulation cost will finally have to be borne by the Government and other stakeholders. This will also derail the financial inclusion programme of the Government and the RBI as PSBs may not be keen to go in for small deposit accounts.
Further, deregulation will have more asset liability mismatch in PSBs than in other banks because of their larger share of SB accounts and presumably bigger share of infrastructure loans extended based on the permanent / core share of SB deposits.
Co-operative banks have a sizeable SB deposits and if interest rate is deregulated it may even sound the death knell for the entire cooperative system which is already under stress.
Options for Deregulation
Though deregulation is desirable and may be necessary to make the monetary policy transmission more effective as claimed by the Reserve Bank, this can wait for some more years till the economy matures and depositors understand the nuances of finance and its implications.
As it is, only a very few percentage of the depositors understand the full implications of deregulation and the possibility and capability of the system taking the depositors for a ride because of greed for profit, general laxity in corporate governance in protecting the interests of the masses and the visible tendency to exploit any situation (even if the deregulation is well intended) through corruption and other malpractices taking advantage of the ignorance of the masses cannot be ignored.
The expectation that deregulation will increase the cost of funds which is already ruling high is also not very conducive for the present.
The ideal time for deregulation would be when the inflation is low, economic growth is good, and the average cost of funds in the economy is at a reasonable level.
No doubt SB interest rate deregulation has its advantages and is welcome in the overall interests of the economy in general and banking system in particular, the timing and approach need to be well calibrated. Partial deregulation in a phased manner can be initially attempted.
Banks which have kept very high level of minimum deposits for SB accounts and have linked the deposit accounts to ATM, Internet and mobile banking and demat accounts can consider deregulating the deposit interest rate and their operations need to be closely monitored by the RBI.
SB accounts maintained by institutions such as charities, trusts, clubs, associations, and NGOsin any bank can also be deregulated. The RBI can also consider keeping a ceiling say Rs 1 lakh for SB accounts. Any amount exceeding Rs 1 lakh should move to either current account or FD account. Interest rate on SB accounts should have a bearing on the inflation and should be periodically revised. SB accounts should be only for individuals.
Surging inflation
The economy is in the grip of high inflation. The cost of deposits and the cost of funds are already very high. In case of deregulation of SB deposit interest rate, the immediate reaction would be to hike the interest rate further beyond the 4 per cent already effected.
Since the NIM is beyond three per cent and banks are reluctant to bring it down, the possibility of banks enhancing service charges to recover the additional interest expenditure cannot be ruled out. Financial inclusion is far from satisfactory. In such a scenario, the timing for deregulation does not seem to be very appropriate.
This article appeared in The Hindu Business Line dt. 23rd May 2011.
Friday, May 20, 2011
Window dressing of Balance sheet
Window dressing and 'undressing' - II
Business Standard / New Delhi May 20, 2011, 0:44 IST
Apropos the editorial “SBI comes a cropper” (May 19), it has become a ritual for new managements in banks to show the old guard in poor light. Such announcements indicate that many things have been and can be hidden. Stakeholders go by the reports that appear in the papers and elsewhere. If SBI’s present position is true, then the earlier reports compiled by chartered accountants and vetted by the auditors and regulators are wrong. The matter should be investigated. The accountants and auditors owe investors an explanation — and so does the Reserve Bank of India.
T V Gopalakrishnan,
Business Standard / New Delhi May 20, 2011, 0:44 IST
Apropos the editorial “SBI comes a cropper” (May 19), it has become a ritual for new managements in banks to show the old guard in poor light. Such announcements indicate that many things have been and can be hidden. Stakeholders go by the reports that appear in the papers and elsewhere. If SBI’s present position is true, then the earlier reports compiled by chartered accountants and vetted by the auditors and regulators are wrong. The matter should be investigated. The accountants and auditors owe investors an explanation — and so does the Reserve Bank of India.
T V Gopalakrishnan,
Monday, May 9, 2011
RBI policy to contain inflation will help boost growth in long run
The Reserve Bank of India has lowered economic growth projections to 8 per cent for the current fiscal. And inflation has been projected to come down from the present 9 per cent to around 6 per cent by March 2012.
The RBI is of the view that controlling inflation is imperative to sustaining growth over the medium term.
The monetary policy statement for 2011-12, released by the Reserve Bank on the May 3, 2011, clearly indicates that inflation will continue to be a challenge and economic growth will have to be sacrificed to check further worsening of inflation and inflationary expectations.
The so-called baby steps introduced since January 2010 to contain inflation have proved to be inadequate to contain inflation and ineffective to transmit the monetary policy mechanism the way the Reserve Bank wants.
Inflation spills over
The pressure of inflation on food prices for the previous year has spilled over into more generalised inflation due to reasons beyond the Reserve Bank's domain.
The trigger for higher inflation can be found in the sharp uptrend in international commodity prices, the quantitative easing and the liquidity surplus in international financial market.
Add to this, higher domestic demand due to improved purchasing power of the people, particularly among the rural masses, coupled with poor fiscal management and fuel price-induced inflationary pressures.
The policy stance taken by the RBI includes increasing the repo and reverse repo rates by 50 basis points each to make the funds dearer and check excessive and speculative borrowings.
Over a period, the repo rate has been enhanced from 4.75 per cent as on January 31, 2010, to 7.25 per cent as on May 3, 2011, and the reverse repo rate has been revised from 3.25 per cent to 6.25 per cent during the same period.
However, the cash reserve ratio (6 per cent) has not been touched to ensure sufficient liquidity in the system, which itself is an indication that the RBI recognises the need for availability of funds for genuine productive purposes and, at the same time, funds are made costly to curb speculative tendencies.
The sacrifice made in the economic growth is justified as inflation beyond tolerable levels will nullify the advantages of growth. The balancing done by the RBI for containing inflation at the cost of growth, though a bit late, is admirable and the economy will derive larger benefits in the long run.
The enhancement of savings bank rate has been long overdue and the RBI has done the right thing by increasing the SB interest rate from 3.5 per cent to 4 per cent. This will benefit a large segment of the population who has only SB accounts.
Though deregulation of SB interest is highly desirable and a discussion paper has been brought out on this aspect, this needs to be examined thoroughly as banks, particularly public sector ones, which operate in the rural and semi-urban areas comparatively in a big way and enjoy heavy SB deposits will face the risk of high cost of funds and asset-liability mismatch in the event of substantial hike of SB interest rate by private sector banks on deregulation.
The timing for deregulation is vital and the present high inflationary conditions and already high cost of funds under the dearer money policy do not seem to be favourable.
Deregulation of SB account can also derail financial inclusion. The hike in SB rate can help improve financial inclusion and attract build up of deposits.
Reduction in NIM
The measures of the RBI will no doubt increase the cost of funds for the banks and the borrowers as well. It is the right opportunity for banks to effect reduction in NIM (net interest margin) which the Governor has been coaxing for the past few months. The NIM of Indian banks has generally been high — above 3 per cent — and they have to manage to bring it down to around 2 per cent.
The changes in provisioning requirements for non-performing loans (NPLs) will bring down the profitability of banks and add to the cost of funds. This also indirectly indicates that bad loans are increasing, reflecting on the poor performance of the economy.
Higher the interest rate more will be the NPLs has been well-established by past experience. Since NPLs in general affect all the stakeholders of banks and are also inevitable in banking business in particular, it is time to think of an inbuilt solution to minimise the impact of NPLs in banks' books by making the borrowers contribute to a common fund based on their own performance rating. This fund can, in the long run, gradually supplement/substitute the provisions and reserves and banks' balance-sheet can look really healthy.
There are several known and unknown risks and to what extent the Reserve Banks' monetary policy measures would be able to achieve the targeted level of inflation is still a big question.
As it is, fuel price increase is overdue and the impact of excise duty enhancement effected on several items in the last Budget is yet to be fully factored. Corruption and black money continue to play spoilsport and supply side management of food articles remains to be fully rationalised and effectively managed.
Asset and commodity prices continue to rise, domestically and internationally, having some adverse impact on monetary measures. The RBI needs to be highly innovative and devise a new approach taking into consideration the areas where it has no control to ensure economic growth with price stability.
T.V.Gopalakrishnan
This article appeared in The Hindu - Business Line dated 9th May 2011
The RBI is of the view that controlling inflation is imperative to sustaining growth over the medium term.
The monetary policy statement for 2011-12, released by the Reserve Bank on the May 3, 2011, clearly indicates that inflation will continue to be a challenge and economic growth will have to be sacrificed to check further worsening of inflation and inflationary expectations.
The so-called baby steps introduced since January 2010 to contain inflation have proved to be inadequate to contain inflation and ineffective to transmit the monetary policy mechanism the way the Reserve Bank wants.
Inflation spills over
The pressure of inflation on food prices for the previous year has spilled over into more generalised inflation due to reasons beyond the Reserve Bank's domain.
The trigger for higher inflation can be found in the sharp uptrend in international commodity prices, the quantitative easing and the liquidity surplus in international financial market.
Add to this, higher domestic demand due to improved purchasing power of the people, particularly among the rural masses, coupled with poor fiscal management and fuel price-induced inflationary pressures.
The policy stance taken by the RBI includes increasing the repo and reverse repo rates by 50 basis points each to make the funds dearer and check excessive and speculative borrowings.
Over a period, the repo rate has been enhanced from 4.75 per cent as on January 31, 2010, to 7.25 per cent as on May 3, 2011, and the reverse repo rate has been revised from 3.25 per cent to 6.25 per cent during the same period.
However, the cash reserve ratio (6 per cent) has not been touched to ensure sufficient liquidity in the system, which itself is an indication that the RBI recognises the need for availability of funds for genuine productive purposes and, at the same time, funds are made costly to curb speculative tendencies.
The sacrifice made in the economic growth is justified as inflation beyond tolerable levels will nullify the advantages of growth. The balancing done by the RBI for containing inflation at the cost of growth, though a bit late, is admirable and the economy will derive larger benefits in the long run.
The enhancement of savings bank rate has been long overdue and the RBI has done the right thing by increasing the SB interest rate from 3.5 per cent to 4 per cent. This will benefit a large segment of the population who has only SB accounts.
Though deregulation of SB interest is highly desirable and a discussion paper has been brought out on this aspect, this needs to be examined thoroughly as banks, particularly public sector ones, which operate in the rural and semi-urban areas comparatively in a big way and enjoy heavy SB deposits will face the risk of high cost of funds and asset-liability mismatch in the event of substantial hike of SB interest rate by private sector banks on deregulation.
The timing for deregulation is vital and the present high inflationary conditions and already high cost of funds under the dearer money policy do not seem to be favourable.
Deregulation of SB account can also derail financial inclusion. The hike in SB rate can help improve financial inclusion and attract build up of deposits.
Reduction in NIM
The measures of the RBI will no doubt increase the cost of funds for the banks and the borrowers as well. It is the right opportunity for banks to effect reduction in NIM (net interest margin) which the Governor has been coaxing for the past few months. The NIM of Indian banks has generally been high — above 3 per cent — and they have to manage to bring it down to around 2 per cent.
The changes in provisioning requirements for non-performing loans (NPLs) will bring down the profitability of banks and add to the cost of funds. This also indirectly indicates that bad loans are increasing, reflecting on the poor performance of the economy.
Higher the interest rate more will be the NPLs has been well-established by past experience. Since NPLs in general affect all the stakeholders of banks and are also inevitable in banking business in particular, it is time to think of an inbuilt solution to minimise the impact of NPLs in banks' books by making the borrowers contribute to a common fund based on their own performance rating. This fund can, in the long run, gradually supplement/substitute the provisions and reserves and banks' balance-sheet can look really healthy.
There are several known and unknown risks and to what extent the Reserve Banks' monetary policy measures would be able to achieve the targeted level of inflation is still a big question.
As it is, fuel price increase is overdue and the impact of excise duty enhancement effected on several items in the last Budget is yet to be fully factored. Corruption and black money continue to play spoilsport and supply side management of food articles remains to be fully rationalised and effectively managed.
Asset and commodity prices continue to rise, domestically and internationally, having some adverse impact on monetary measures. The RBI needs to be highly innovative and devise a new approach taking into consideration the areas where it has no control to ensure economic growth with price stability.
T.V.Gopalakrishnan
This article appeared in The Hindu - Business Line dated 9th May 2011
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